Op/Ed

Energy prices are smoking hot

The Chart Of The Week is UK Natural Gas. Nearby futures hit All-Time highs in August – then quadrupled from there by early this week – only to fall in half by Friday (Putin indicated that Russia could increase supply.)

New York Natural Gas nearby futures more than quadrupled from last year’s lows – more than doubled since June. North American Natgas prices are less than half European and Asian prices, but there is no easy Arb – there is not enough capacity to move LNG across the oceans to balance the different market prices. (So – don’t buy NY Natgas just because European Natgas is going ballistic – they are two very different markets.)

WTI nearby futures have rallied nearly 30% in the last seven weeks – hitting $80 for the first time in seven years.

The uranium ETF doubled from January to September – hitting 7-year highs.

Even “dirty” coal has soared in price this year. China ordered local producers to ramp up production and decided to start buying coal from Australia (after banning Aussie coal earlier this year.) India, where 60 -70% of total electrical generation comes from coal-fired plants, is desperately short of coal.

High prices are the best remedy for high prices

High prices (usually) dampen demand and bring forth supply. OPEC+ had the opportunity to raise their production quotas by more than the pre-planned 400,000BBL at their last meeting – but they didn’t. However, it’s easy to imagine that some OPEC+ producers will ramp up production. Canada is increasing exports to the US (chart below in the section on the CAD.) American frackers, funded with private equity, will increase production, and high prices will dampen demand – in the short term.

The COP26 conference in Glasgow October 31 – November 12

These folks want to stop the use of fossil fuels. They want governments around the world to set firm timelines to ban the use of FF. They believe that the dangers from climate change are significant enough to warrant a “transition” to non-FF energy sources that will be disruptive, messy, volatile, incredibly expensive and inflationary.

Pension funds (including the BIG ones in Canada) are dumping FF investments according to their ESG mandates. People who don’t mind social disapproval may see this as an opportunity – if they think that FF supply shortages, relative to demand, will take FF prices higher during the global energy “transition” period.

Interest rates keep rising

The yield on the US 10Y Treasury ended the week at a 4-month high of 1.61% – up ~40 bp from the YTD lows made in August. Rising inflationary pressures, rising prices of tangible goods (commodities, real estate) and the likelihood of less Fed “Q” in the future pressured bond prices. For the last few weeks, stocks and bonds have both trended lower.

This is a chart of the long bond futures contract at the CBOT. Falling prices mean rising yields.

This is a chart of the famous 2-Billion Euro 100-year bond issued by Austria last year with a yield (at issue) of 0.88%. As interest rates have inched higher, prices on this bond have plummeted! Longer duration bonds make more “dynamic” price moves than shorter-duration bonds.

Stock indices hit a low early in the week and bounced

The Nasdaq (with a heavy weighting of long-duration tech stocks) has been the weakest of the major indices the past few weeks, but all of the major North American indices are down from their recent All-Time highs.

The US Dollar Index remains near 1-year highs

The USD has been strong against the Euro and the Yen the past few weeks. The CAD and the NOK have rallied against the USD on higher oil prices.

The CAD traded above 80 cents on Friday for the first time in two months as the Canadian September employment report was much stronger than the American report. Rising energy markets and rising commodity indices have also given the CAD a boost. Interest rates are higher in Canada than in the US, and the BoC looks set to continue with its tapering program. (Can 5Yyields = 1.26%, US 5Yyields = 1.06%.)

The new Enbridge Line 3 oil pipeline from Alberta to Wisconsin has begun operation and will significantly increase Canada’s ability to generate revenue from exporting crude to the USA. This increase in crude exports should be positive for Canada’s trade balance and, therefore, another boost for the CAD.

My short term trading

The only position I carried over from last week was long AUD calls. I closed the trade for a slight loss Friday. When I closed the trade, the AUD was about 20 ticks higher than when I entered the trade but time decay over the past two weeks resulted in a loss. I had been looking for the AUD to trade towards 74 cents (booming commodity markets and a nice double bottom), but it wasn’t happening, so I hit the sell button – the trade wasn’t working.

Part of my thinking on the AUD trade was that speculators were record short of the AUD – if it started to rally, those shorts might begin to cover, which could accelerate the rally. I may look for another opportunity to buy the AUD.

Last week, in the “On my radar” section, I wrote that the strong rebound in the stock indices on Friday, October 1, may have signalled the beginning of a bounce. I bought the S+P on Monday after the market dropped ~60 points from Friday’s close. I had a reasonably tight stop that nearly got hit overnight, but the trade looked great once the Tuesday day session began. I moved my stops higher to lock in a modest profit.

At Tuesday’s best levels, I was ahead ~70 points, and I thought if the market rallied above Friday’s strong close that it could run higher. I had to stay with the trade.

The market fell back from that 70 point gain late in the day, weakened more overnight, and stopped me out for only a 16 point gain.

I bought the S+P and the Nasdaq 100 mid-day Wednesday after the market had recovered from overnight lows and sold those positions for a decent gain on the Thursday opening. I ended the week flat. My P+L was up ~0.75% on the week.

On my radar

The popular thinking seems to be that inflation is running hotter than the Fed expected and will not be transitory. Inflationary pressures are coming from re-opening demand and supply chain shortages and the effects of “too much” monetary and fiscal stimulus. I wonder how much of that “popular thinking” is already in the price.

I’m happy to start next week with no position and watch price action with an open mind, but my bias is that the “energy crisis” headlines are the sort of thing that happens just before a correction.

China

I watched several excellent video interviews on Hedgeye this week that got me re-thinking my position on China. Is it possible that China is “fragile” in the Nassim Taleb sense of the word? The government is obsessed with control – and the market tends to believe that the Chinese government gets what it wants (at least within China.) What if that’s not true? Real estate accounts for ~70% of retail investment. The astonishing growth in China over the past 20 years has been debt-financed.

Does the ROW want to have less to do with China? Do you want to put your money / your people into China? (Think hostage diplomacy.) Does China want to have less to do with the ROW? China has been a big part of global GDP (and a HUGE part of commodity demand), but what if Xi leads China to withdraw (somewhat) into itself? What if the “China is going to take over the world” story is based upon a Potemkin Village?

Thinking about China in this way reminds me of how Japan was going to take over the world in the late 1980s – and didn’t. The parallels to today’s China may be weak on specifics, but I’m thinking in terms of market psychology, and we’ve seen this movie before.

Powell

His term is up at the end of January 2022 – Biden will soon have to re-appoint him or nominate someone new. If he is not re-appointed, then his replacement will likely be even more dovish on monetary policy (and more hawkish in terms of regulation.) In one of those Hedgeye interviews, Grant Williams wondered if maybe the Dems want to remake the Fed like Trump transformed the Supreme Court. Powell looked like a sure thing a couple of months ago, but with the trading scandals and Elizebeth Warren scolding him, maybe he’s a 50/50 bet now.

This photo and caption are from The Macrotourist.

Thoughts on trading

I spend a lot of time reading opinion pieces and research reports, watching market videos and listening to podcasts – but I’m not looking for buy and sell recommendations. I’m hoping to get an idea that will start me thinking about a market in a way that is new to me – an idea that will have me asking myself, “Where’s the trade?”

When I spoke at investment conferences, I knew that people wanted buy recommendations, especially recommendations that supported trades they had already made.

The problem with buy/sell recommendations is that they are only a tiny part of the trading process. There is SO much more to trading! For instance, How much do you buy? When do you buy? How do you execute the trade? What is your time horizon? What is your risk tolerance? What do you do as time passes and the market changes? What gets you out of the trade? Does the trade create a concentration problem?

I also spend a lot of time looking at charts. I especially like to create different “pair” charts (this comes from trading currencies a lot over the years.) For instance, I can look at the CAD in terms of the USD, but what does it look like in terms of the EUR, YEN, or AUD? What does the S+P look like in terms of a commodity index?

I can spend a lot of time doing these things and not find any good trading ideas. I’m ok with that. It’s part of my trading process.

Quotes from the notebook

Last week I wrapped up the Notes with a few quotes from my notebook. I’ve got 100s of quotes that I’ve collected over the years – maybe the quotes will become a regular feature.

Research is essential, but the tactics you use around the research are what makes money. Bill Fleckenstein RTV Jan 2020 (My comment: What you do with a trade once you have it on is more important than what got you into the trade in the first place.)

You gotta know when to be a pig. Stan Druckenmiller (I think that quote was in the first Market Wizards book. 1989.) (My comment: sometimes you have to step up your size. Rarely, but sometimes.)

Too many hedge funds are simply leveraged beta masquerading as alpha. Kevin Muir The Macrourist 2015 (My comment: Hedge funds travel in packs.)

It’s not a question of enough, Pal. It’s a zero-sum game. Someone wins. Someone loses. Money itself isn’t lost or made; it’s simply transferred from one perception to another. Gordon Gekko, Wall Street 1987 (My comment: I love this quote! Perceptions change. The trader with the correct perception, for that point in time, wins.)

Subscribe: You have free access to everything on this site. Subscribers receive an email alert when I post something new – usually 4 to 6 times a month.

Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Therefore, this blog, and everything else on this website, is not intended to be investment advice for anyone about anything.

Schachter’s Eye On Energy – October 6th

Each week Josef Schachter gives you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold (SER) newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more

EIA Weekly Data: The EIA data on Wednesday October 6th surprised energy bulls once again with increases in Commercial Crude OIl Stocks of 2.3Mb (forecast was for a decline of 0.4Mb), and an increase in US crude production of 200Kb/d as US production recovered to 11.3Mb/d (just short of the 11.5Mb/d before the hurricanes started). We have been highlighting these potentials over the last number of issues and they are now occurring. This should put a cold shower on the crude bulls and drive prices down below US$70/b in the near future.

In detail:

  • Commercial Crude Oil Stocks rose by 2.3Mb on the week to 420.9Mb. Energy bulls point to this being 72.0Mb below last year’s pandemic level, but it is close to the 422.6Mb seen at this time in 2019. So we don’t see crude inventories as too low. Gasoline inventories rose by 3.3Mb to 225.1Mb and are close to the 230.0Mb in storage at this time in 2019.
  • Refinery Activity rose 1.5 points to 89.6% from 88.1% last week as Gulf Coast refineries increased activity. This is now above pre-pandemic levels of 85.7% at this time in 2019.
  • In the coming months we expect to see US crude oil production rising and reaching 12.0Mb/d as the drilling pace picks up sharply and much of the remaining shut in offshore production returns. This week’s level of 11.3Mb/d (up 200Kb/d this week) supports this view.
  • Demand for all products rose last week. Total Product Demand rose 1.135Mb/d to 21.526Mb/d as Distillate Demand rose 392Kb/d and Other Oils rose by 390Kb/d. Gasoline consumption picked up a modest 28Kb/d to 9.274Mb/d while Jet Fuel Consumption rose by a decent 267Kb/d to 1.694Mb/d (1.76Mb/d consumed in 2019 at this time). Cushing Inventories rose by 1.5Mb/d to 35.5Mb compared to 56.5Mb last year and 41.7Mb two years ago.

This was on an overall basis a bearish report and as we see more seasonal inventory builds in the coming weeks, crude oil should fall US$10-15/b during Q4/21.

OPEC October Supply Meeting: OPEC met on Monday October 4th and approved their originally planned 400,000 b/d increase in quotas. This was despite significant pressure for larger volume increases from the US, China and India, their biggest consumers. Crude oil bulls rejoiced and pushed WTI up to a new 2021 high of nearly US$79.50/b on Monday with the support of short covering and margin calls on bearish futures and options traders, who were required to reverse their positions or add to their margin capital. The basic problem with the 400,000 b/d monthly increase is that some of the members getting higher quotas do not have capacity to raise production. For example in August OPEC increased quotas by 400,000 b/d but only 151,000 b/d of new oil was brought on (the Saudis +69K b/d, UAE +55K b/d, Iraq +90K b/d and Angola +43K b/d). On the downside, producers such as Nigeria decreased production by 114K b/d and the Congo by 14K b/d. It is unlikely that the full 400Kb/d was brought on in September (data to be released Wednesday October 13th). If OPEC wanted to, just Iraq, Kuwait, Saudi Arabia and UAE could increase production almost immediately by 3-4Mb/d. This would lower crude prices and keep pump prices reasonable. If not, demand will fall even more sharply than is now likely. The current short-term OPEC greed pricing will surely fall to depressed prices again and hurt OPEC members severely. Don’t they remember 2009 and early 2020?

OPEC is forgetting history. Every time they have allowed a price spike to occur and did not keep prices from impacting demand, the price of crude after spiking, fell greater than 50% (just check 2008, 2014, 2018 and 2020). Demand is sluggish in the US and is falling in China as they work to clear up the air quality ahead of the 2022 February winter Olympics starting in less than four months.

Baker Hughes Rig Data: The data for the week ending October 1st showed the US rig count rose by seven rigs (rose nine rigs in the prior week). Of the total of 528 rigs working last week, 428 were drilling for oil and the rest were focused on natural gas activity. This overall US rig count is up 98% from 266 rigs working a year ago. The US oil rig count is up 126% from 189 rigs last year at this time. The natural gas rig count is up a more modest 34% from last year’s 74 rigs, now at 99 rigs. The Permian saw an increase of three rigs (up one last week) to 263 rigs and is up 104% from 129 rigs last year at this time.

Canada had a rise of three rigs (up eight rigs in the prior week) to 165 rigs. Canadian activity is now up 120% from 75 rigs last year. There were 97 oil rigs working last week, up from 37 last year. There are 68 rigs working on natural gas projects now, up from 38 last year.

The material increase in rig activity over a year ago in both the US and Canada should continue to translate into rising liquids and gas production over the coming months. The data from many companies on their plans for the Q4/21 and forecasts for 2022 support this rising production profile expectation.

Conclusion:

We should see more weekly builds in Commercial Crude Stocks around the world as inventories rebuild to meet the winter 2021-2022 needs. Normal fall season builds are 2-3Mb per week (as we saw this week). If we see any increases over 5Mb in any week, that would put meaningful downward pressure on crude prices. The current spike in prices was speculative in nature and is not sustainable.

Bearish pressure on crude prices:

  1. Covid caseloads are growing around the world. Just note the challenges faced in Alberta. Formal vaccine documents are to be the norm in Canada going forward. In the US the death rate is >2,000/day and over 703K deaths have been reported. Worldwide the death count is now 4.81M. This pandemic has taken more lives in the US than the 1918-1919 Spanish Flu (675,000 estimated).
  2. Demand is under pressure as high prices for most food and other daily necessities make spending decisions tougher for consumers. Yesterday, I filled our car, spending over C$71 to fill it – the first over $70 fill in years. Normally C$50 would have done it. So this gouge in prices will surely impact most consumers buying behaviour in the coming months.
  3. Global ports remain clogged with containers and delivery problems could last into 2023 according to the CEO of Dubai’s DP World, the largest operators of ports.

Bullish pressure on crude prices:

  1. A short squeeze on bearish positions in the futures and options markets on crude and natural gas has spiked up prices. It could go higher but as these positions are reversed, the parabolic price spike could reverse sharply on any negative news.
  2. Spot prices in short supply areas like Europe have lifted natural gas prices to over US$32/mcf in Europe and over US$36/mcf in parts of Asia (NYMEX today US$5.84/mcf – AECO C$4.87/mcf).
  3. Russia has held back supplies of natural gas to Europe as they pressure the EU and Germany to open the new NordStream 2 pipeline. The Greens and the Free Democrats, planning to join the new Government, are against the project. Opening the pipeline should end the shortage of natural gas on the continent. Once the political maneuvering is over this should start up. The Russians are starting to fill the pipeline with gas as it tests for structural integrity and plans for shipping more gas for the upcoming winter. The German regulator still needs three months to complete certification. The Danish Energy Agency has accepted that the line can be put into operation.

CONCLUSION: 

WTI has fallen to US$75.48/b (down US$1.48/b) due to the rise in Commercial Crude Stocks. We see prices as having over US$15/b of speculative value which should disappear as Stocks continue their seasonal build. The question for us is what is happening to world wide demand as the two largest economies in the world slow down? 

Many industrial plants in China have been closed due to the high cost of fuel and the Government’s plan to lower emissions in the Beijing area for the upcoming winter Olympics from February 4th to the 20th. Clean air is needed for the event and China wants to show it is making progress on its climate initiatives. This will dampen China’s consumption of fossil fuels over the next four to six months. 

Energy Stock Market: The S&P/TSX Energy Index currently trades at 149 as natural gas stocks rose sharply over the last week following the whirlwind gaping natural gas prices in the international spot market. The S&P Energy Bullish Percent Index has reached 100% again. This is a clear SELL signal. Energy stocks could fall 30-40% in the coming months.

Our October SER Interim Report comes out tomorrow Thursday October 7th with details on the weakening general stock market and its expected impact on the energy sector.

Market pressures such as the debt ceiling battle in the US, rising bond yields, the problem of Congress’s approval of the two stimulus bills and the US$3.5T price tag, the planned 40 new or increased taxes, and rising inflation are now drags on the general stock market. The domino starting the overall market decline appears to be the overleveraged and retrenching real estate sector in China. Following on this problem is the very politically tough situation in the US as all Republicans are opposed to the Biden Human Infrastructure proposal and a few moderate Democrats are also opposed.  Liberals and progressives want a bigger package and moderates want to see it lowered in price and fully paid for with taxes. The next few weeks could see some of the Biden policy agenda face defeat which could rock the financial markets.

We cover this in detail in our Schachter Energy Report. Over the next few months any of these events could lead to a domino effect of over leveraged companies getting into trouble and financial markets declining materially. The Dow Jones Industrials Index is now below 34,000 (market peak for Dow Jones Industrials Index at 35,631 in mid-August 2021) and could fall to below 30,000 in Q4/21 and to <25,000 in Q1/22. As predicted, we have already seen three down days of more than 500 points for the Dow Jones Industrials Index and expect many more in the coming months.

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Trading Desk Notes For October 2nd

Major stock indices drop to 10-week lows – then bounce

The most significant broad market decline since Biden’s election (S+P and DJIA down ~6%, Nasdaq 100 down ~7.5%) happened right on schedule. For the previous 35 years, September (especially the 2nd half) has typically been the weakest month of the year – followed by the best quarterly returns in Q4. Is the Merck covid pill kicking off another strong fall rally?

A sharp fall in bond prices accelerated the late September weakness in stocks

Bond yields spiked higher after the Fed signalled that they would soon begin tapering their $120 billion a month QE program. With Central Banks around the world likely to reduce their respective QE programs (totalling ~$300 billion a month), who will buy bonds? Is “persistent” rather than “transitory” the new CB watch-word for inflation?

Stalled stimulus programs in dysfunctional DC add to bearish stock market sentiment

Massive QE and massive government stimulus were the two significant drivers behind the 100% stock market rally off the 2020 lows. With Biden struggling to unite Democrats (let alone soliciting Republicans) to support his key proposals, it looks like much less-than-expected stimulus will be coming from DC. As Joe Manchin (Democratic Senator from W. Virginia) says, “We’ve spent more than $5-Trillion since March 2020. How much is enough?”

Dramatic changes in Chinese government policies have added to bearish stock market sentiment

Under the banner of “Common prosperity for all,” Xi Jinping is reshaping the social order in China and (please forgive my cynicism) ensuring his position as the Great Leader. Tech shares have tumbled, property shares have wobbled, but the government seems intent on policy compliance.

Widespread energy shortages in China are dampening economic growth to the point where the government this week ordered energy providers to “secure supplies at all costs.”

Transitioning to Green Energy will be bumpy

Nat Gas prices in the UK and Europe have been soaring. Inventories are low ahead of the upcoming winter heating season. Electricity prices across Europe are at record highs.

New York Nat gas registered the highest monthly close in September since November 2008.

The uranium ETF traded at a 7-year high.

Brent crude traded above $80 for the first time in three years.

The US Dollar ended September at a 15-month high

I’ve (generally) been bullish on the USD since its “inflection point” the first week of January when the mob stormed the Capitol Building. The USD has rallied ~6% since those January lows and is now near the mid-point of its 20-year trading range.

The USD has been trending higher in September as the stock market has been falling. These are two sides of the same risk-off coin.

Over the past 12 weeks, speculators have gone from (marginally) net short the USD to long ~$16Billlion as of Sept 28. This is the largest spec net long position since the Covid panic of Feb/March 2020.

The broad commodity indices have had a great run from last year’s lows

The leading commodity indices hit 20-year lows in April 2020 following a brutal bear market from the 2011 highs. Since last year’s lows, the energy sector has been the best performing sector, but all sectors have had a substantial advance driven by supply/demand imbalances.

The Goldman Sacs broad commodity index (with a heavy energy weighting) is up ~160% from last year’s lows, while the CRB Index is up ~120%.

My short term trading

I started this week flat. Last week, in the On My Radar section, I wrote that I thought the bounce in the stock indices might have been “reflexive” and that if the rally rolled over, “I would be looking for opportunities to short stock indices, buy the USD, and I might even buy bonds!

The S+P initially traded higher Sunday night but rolled over such that the Monday day session opened slightly lower than Friday’s strong close. I shorted the market at 4432 (circled) during the Monday day session with a stop just above Friday’s high. The market fell overnight and tumbled hard on the opening of the Tuesday day session. With little follow-through to the weak opening, I covered my short at 4355 (circled) for a gain of ~80 points.

I did not buy the USD, and I did not buy bonds.

On Monday, I bought 74 cent strike long-dated Australian Dollar calls with the AUD trading near 73 cents. The AUD trade was counter to the bearish thinking that got me short of the S+P, so I saw it as a bit of a hedge. The AUD calls had much less net risk than the S+P futures, so I was heavy “net” risk-off.

Since early summer, speculators have been aggressively building their net bearish AUD position and are currently holding a record-sized short position. My thinking was that if the AUD rallied above 7325-50 (without first taking out the August lows) that some of those spec shorts might start to cover their positions and drive AUD higher.

Note the low pivot point (circled) on August 19. That date was a Key Turn Date for several markets, including an interim high for the USD. Early September, the next circled date, was a temporary low for the USD and a high for the S+P. For the past few months, the AUD has traded in line with the S+P and opposite to the USD.

The long AUD calls were my only position at the end of the week, and they were slightly underwater. My P+L was up ~0.8% on the week.

My trading was subdued this week because I knew I would be away from my desk and unable to monitor markets for about 14 hours mid-week. My wife and I visited a small remote town to pick a puppy from a newborn litter. Barney will come to live with us in mid-November after spending eight weeks with his mother. Photo below.

On my radar

As noted above, Q4 has typically been the strongest quarter of the year for the major stock market indices for the past 35 years. After making new lows, the strong rebound on Friday may be the start of another leg in the rally. I may be a buyer if the strength continues into next week.

Biden will have to soon decide about re-appointing Powell. If he does not re-appoint Powell, then the next Fed Chair will be even more dovish, which will not be good news for the USD but will be good news for gold. The stock market will probably embrace an even more dovish Fed Chair.

The drama around the energy markets “feels” overdone, short-term, but is probably only a taste of the difficulties that will be encountered during the multi-year government-inspired transition from fossil fuels to green energy.

The surge in the commodity indices also “feels” overdone, short-term. The supply-chain dislocations and shortages are undoubtedly real, but, as always, the question is, “How much is in the price?”

Thoughts on trading

For the past 20 years or so I’ve jotted down brief notes or quotes about trading in a special notebook. The Denise Shull quote that I used in last week’s Notes is the latest entry in my notebook.

I’ve probably got enough “material” in my notebook to write a book, so I’ll start sharing some of those nuggets in this space every week. The point in doing that will be to inspire my readers to think twice about some of the ideas – and maybe they will be better traders as a result. So here we go:

“Wall Street’s job is to sell people things they should not buy. Like “short volatility.” Michael Lewitt – the Credit Strategist – February 2018

“Volatility will remain low as long as interest rates remain low. I can’t argue with that.” JMP Clarke 2018 (Jim and I had been discussing how option vol was lower than it otherwise would be – because so many people were selling vol to “earn income” in a low-interest rate, reaching-for-yield world. We agreed that few of those people had any idea of their risk exposure.)

Nobody gets paid for originality – you get paid for making money.” Christan Siva-Jothy – Prop Trader – Inside the House of Money 2005

Every day, I assume every position I have is wrong.” PT Jones Market Wizards 1989

“When a market is going down, you have no idea how far down is.” Dennis Gartman, 1990’s

“I’ve never thought in terms of beating a benchmark. If I used a benchmark, and I was down, but not as much as my benchmark, I would not see that as a “win.” I know most money managers use benchmarks, but, for me, Absolute Returns are the only real measure of performance.” Victor Adair, 2005

Nobody ever thanks you for not taking a holiday.” Peter Appleby 2008

Subscribe: You have free access to everything on this site. Subscribers receive an email alert when I post something new – usually 4 to 6 times a month.

Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Therefore, this blog, and everything else on this website, is not intended to be investment advice for anyone about anything.

Schachter’s Eye On Energy – September 29th

Each week Josef Schachter will give you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold (SER) newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We also hold quarterly webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more

EIA Weekly Data: The EIA data on Wednesday September 29th surprised energy bulls with increases in Commercial Crude OIl Stocks of 4.6Mb (forecast was for a decline of 2.5Mb), an increase in Total Stocks of 10.9Mb (excluding SPR changes), an increase in US crude production of 500Kb/d as Offshore US crude production (recovers post the hurricanes), and Total Demand fell by 754Kb/d to 20.4Mb. We have been highlighting these potentials over the last number of issues and they all are now occurring. This should put a cold shower on the crude oil bulls and drive crude prices down below US$70/b in the near future to below US$60/b as we have been forecasting.

In detail:

  • Last week 500Kb/d came back on and overall US production is now 11.1Mb/d, just below the 11.5Mb/d produced before the first hurricane closed offshore production. There are still 400Kb/d to come back on stream. Some of the production, approximately around  200-250Kb/d, may take some time to return as Shell announced that major infrastructure repairs are needed.
  • Commercial Crude Oil Stocks rose by 4.6Mb on the week and would have risen by 870Kb more if not for net exports falling by 124Kb/d. Gasoline Inventories rose by 0.2Mb and Refinery Activity rose 0.6 points to 88.1% from 87.5%, as Gulf Coast refineries increased activity. This is now above pre-pandemic levels of 86.4%, this time in 2019. In the coming months we expect to see US crude oil production rising and reaching 12.0Mb/d as the drilling pace picks up sharply and much of the remaining shut in offshore production returns.
  • Demand for all products fell last week. Total Product Demand fell 754Kb/d to 20.4Mb/d as consumption of propane and other oils fell. This compares to 21.2Mb/d consumed at this time in 2019 before the pandemic. Gasoline consumption picked up 502Kb/d to 9.4Mb/d (same as in 2019 at this time) while Jet Fuel Consumption fell 60Kb/d to 1.43Mb/d (1.5Mb/d consumed in 2019 at this time). Cushing Inventories rose by 0.2Mb/d to 34.0Mb compared to 56.1Mb last year and 40.7Mb two years ago.

This was a very bearish report and as we see more seasonal inventory builds in the coming weeks crude oil should fall over US$10/b during Q4/21.

Baker Hughes Rig Data: The data for the week ending September 24th showed the US rig count rose by nine rigs (rose nine rigs in the prior week). Of the total of 521 rigs working last week, 421 were drilling for oil and the rest were focused on natural gas activity. This overall US rig count is up 100% from 261 rigs working a year ago. The US oil rig count is up 130% from 183 rigs last year at this time. The natural gas rig count is up a more modest 32% from last year’s 75 rigs, now at 99 rigs. The Permian saw an increase of one rig (up five last week) to 260 rigs and is up 108% from 125 rigs last year at this time.

Canada had a rise of eight rigs (up 11 rigs in the prior week) to 162 rigs. Canadian activity is now up 128% from 71 rigs last year. There were 96 oil rigs working last week, up from 33 last year. There are 65 rigs working on natural gas projects now, up from 38 last year.

The material increase in rig activity over a year ago in both the US and Canada should continue to translate into rising liquids and gas production over the coming months once the impact of the hurricane/storm season is over. The data from the many companies and their plans for the rest of 2021 and forecasts for 2022 support this rising production profile expectation.

Conclusion:

We should see weaker crude oil consumption reports and weekly builds in Commercial Crude Stocks around the world as inventories rebuild to meet the winter 2021-2022 needs. Normal fall season builds are 2-3Mb per week. If we see any increases over 5Mb in any week, that would put meaningful downward pressure on crude prices. The current spike in prices was speculative in nature and is not sustainable. Bulls may see this week as an aberration but if we see repeats of builds and strong builds over 2-3Mb/week, then crude prices are very vulnerable. Just remember how Lumber rose from US$441 in October to US$1733 in May 2021 and then fell to US$448 in August when demand waned as high prices killed off demand.

Bearish pressure on crude prices:

  1. The Mu variant is following the deadly Delta variant and is gaining victims around the world. This variant started in Colombia and now is impacting 39% of all people infected with the pandemic disease. This variant is now seen in more than 40 countries and in 49 US States. A London immunologist at the Imperial College in London says “that the early research indicates it appears to be highly effective at evading immunity”. Delta caseloads are growing around the world. Just note the challenges faced in Alberta. Formal vaccine documents are to be the norm in Canada going forward. In the US the death rate is now back over 2,000/day and over 688K deaths have been reported. Worldwide the death count is now 4.75M.
  2. The Saudis are pricing crude oil for October delivery to Asia at US$1/b lower than previous months, as the fight for market share in the patchy economies in the area continues. China demand is especially sloppy. China plans on selling 7.4Mb from their state crude reserves on September 24th to cool off prices. Russia has announced that they plan on adding nearly 7% in additional production in 2022. OPEC meets next Monday (October 4th) and plans to approve their 400Kb/d increase in production for November. However major consuming nations are pressuring them to increase production even further as high prices are negatively impacting their economies. The King and Crown Prince are being pressured to increase production by the Presidents of the US and China and we don’t see the Saudis ignoring this pressure. OPEC countries like Saudi Arabia, Iraq, Kuwait and the UAE together could add 3-4Mb/d quite quickly if they want to.

Bullish pressure on crude prices:

  1. Forest fires and the lack of wind in the North Sea and other areas have crippled wind power from onshore and offshore facilities, cutting off much of this renewable electricity supply. This has driven natural gas prices to over US$20/mcf in Europe and over US$30/mcf in parts of Asia (NYMEX today US$5.62/mcf – AECO C$2.48/mcf). Prices for natural gas should drift over the near term but should exceed recent highs if this winter is colder than normal and storage is low. Goldman Sachs sees Brent rising another US$10/b in Q4/21 to US$90/b.
  2. Some OPEC countries like Nigeria, Libya and the Congo are having problems keeping crude oil production up due to their lack of funding for operations.
  3. The UK has a shortage of energy product delivery drivers and is now opening its border to 5,000 EU accredited individuals. In addition they plan on utilizing the military logistics system to increase deliveries. Hoarding has occurred as people worry about running out of fuel for their vehicles. Recently a purchase limit of 30 pounds worth of petrol has been implemented by many petrol stations.
  4. Russia has held back supplies of natural gas to Europe as they pressure Germany to open the new NordStream 2 pipeline. The Greens and the Free Democrats, planning to join the new Government, are against the project. Opening the pipeline should end the shortage of natural gas on the continent. Once the political maneuvering is over this should start up.

CONCLUSION: 

WTI has risen to US$75.48/b due to the rising price of natural gas, the shortage of electricity in many OECD and developing countries, and massive speculative interest. It appears that high prices again are the solution for high prices as was seen in Q2/08 when crude spiked to US$147/b and then fell to US$34/b in Q1/09, and in April 2020 when prices went negative and ended the rout in crude prices, recovering to US$42/b just a few months later. Many industrial plants in China have been closed due to the high cost of fuel and the Government’s plan to lower emissions in the Beijing area for the upcoming winter Olympics from February 4th to the 20th. Clean air is needed for the event and China wants to show it is making progress on its climate initiatives. This will dampen China’s consumption of fossil fuels going forward. Supplier plants producing items for Apple and TESLA have suspended production. Supply chain issues are getting worse.

A breach of US$70/b is likely before the end of October. The health of the largest world economic zones (the US, China and the EU) and how large the seasonal crude oil storage builds are will impact how much crude prices will retreat. During Q4/21 we see WTI prices breaching US$60/b. This may sound heretical to energy bulls but just remember that the pendulum does swing and that inflection point is here now. Proof is evident from today’s EIA report.

Energy Stock Market: The S&P/TSX Energy Index currently trades at 144 as natural gas stocks rose sharply over the last week following the whirlwind of gaping natural gas prices in the spot market.

We expect that as crude oil prices decline, the recent low for the Energy Index at 109.72 will be breached. The key level to watch is US$61.74/b. If this occurs in Q4/21 then the Energy Index should head towards 100. We recommend caution, lowering exposure and holding cash for the next low risk entry point. The energy and energy service companies with the most downside are those with stretched balance sheets and have missed production, revenue or EBITDA forecasts. Take profits on decent up days and raise cash.

Subscribe to the Schachter Energy Report (SER) and receive access to our two monthly reports, all  archives, Webinars, Action Alerts, TOP PICK recommendations when the next BUY signal occurs, as well as our Quality Scoring System review of the 30 companies that we cover. We go over the markets in much more detail and highlight individual companies’ financial results in our reports. Our October Interim Report comes out on Thursday October 7th and covers the weakening general stock market and its expected impact on the energy sector.

The Evergrande Chinese property developer insolvency problem appears to be the catalyst for the overall stock market decline in China and many other countries around the world. The US$305B of debts that they can’t pay has large portions owed to foreign investors and lenders. Interest payments due last week were not paid and after the 30 day grace period is over it will  push the entity into bankruptcy or Beijing controlled restructuring. The size of this problem is massive as they were building 1.6M apartments and homes that they don’t have funds to finish and as well, have taken large deposits from buyers. Protests at company offices are picking up by irate home buyers and suppliers. In any year they employ over 3M people in their construction activities and directly employ over 200,000 people. This could spiral out of control and become the ‘Lehman’ event to start a new financial crisis. Banks and other financial institutions as well as local governments are very vulnerable. Beijing is in the process of setting up protective barriers to contain the damage this could do to the real estate wealth focus of the country.

Other market pressures are the debt ceiling battle in the US, rising bond yields which lower the value of the stream of earnings, the problem of Congress’s approval of the two stimulus bills and the planned 40 new or increased taxes to pay for the social infrastructure’s US$3.5T price tag. This is very politically tough as the Republicans won’t support the social infrastructure Biden proposal and some Democrats are also opposed.  Liberals and progressives want a bigger package and moderates want to see it lower and paid for. The next few weeks could see defeats which could rock the financial markets.

We cover this in detail in our Schachter Energy Report. Over the next few months any of these events could lead to a domino effect of over leveraged companies getting into trouble and financial markets declining materially. The Dow Jones Industrials Index now at 34,460 could fall to below 30,000 in Q4/21 and to <25,000 in Q1/22. We have already seen two big down days of more than 500 points for the Dow Jones Industrials Index and expect many more in the coming months. Yesterday the Dow fell 1.6% or 569 points while the overvalued NASDAQ fell 2.8% or 423 points.

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Trading Desk Notes For September 25th, 2021

Evergrande Monday

The Dow Jones futures contract dropped >1,300 points from last Friday’s highs to Monday’s lows and then rallied back > 1,300 points to Thursday’s highs – a ~2,600 point round trip in five trading sessions.

Here’s my take: The leading stock indices had rallied >100% from the March 2020 lows without so much as a 5% correction since October 2020. Monetary and fiscal stimulus had been the principal drivers of the rally; the rally was showing many signs of speculative excess, and any “catalyst” could trigger a correction. Looking ahead, the market could see that the Fed was going to start “taking away the punch bowl” (even if only a spoonful at a time), and the increasingly dysfunctional environment in Washington meant that fiscal stimulus was going to be scaled back. (Fiscal fatigue, as my friend Kevin Muir, calls it.)

In August, I wondered if developments in China would be contagious, but North American markets seemed “complacent,” with stock indices inching higher and higher while volatility metrics were near multi-year lows.

Last week I wrote: “The answer (to the contagious question) appeared to be “No,” in August, but now that the “stress” of September has arrived, the answer might be, “Yes, but with a delay.

It was easy to imagine contagion within the over-levered Chinese real estate market, especially considering the recent “anti-capitalist” bend of the CCP (“homes are for living in – not for speculation”). It was also not difficult to imaging that contagion within China could trigger corrections in other markets.

The critical question seems to be, “What will the CCP do?” They are reshaping Chinese society (“common prosperity for all”) and seem more concerned with policy compliance than short-term market reactions. I expect more companies will “fail” with executives arrested, but I do not expect the CCP will allow chaos.

The market seems to have drawn the same conclusion (as Evergrande moved from a page 16 story in August to a front-page feature on Monday) and has bounced back from the lows.

What’s next?

The stock indices have historically been weak in September (especially the 2nd half), and then they rally into year-end. That may happen, but I can also imagine that the decline from the early September All-Time highs is only the first leg of a more significant correction.

An alternative view to the seasonal norm would be that this week’s rally has been a “reflexive” bounce from a market that is “used to” going up and that if it rolls over without making new highs and takes out this week’s lows, a deeper correction may develop.

Interest rates

As the S+P futures plunged ~180 points from last Friday’s highs to this Monday’s lows, Treasury bonds barely moved – they stayed inside the relatively narrow range they’ve been in since mid-July. I thought that was curious. Where was the “haven” bid for bonds when the stock market was in free fall? Even the Japanese Yen was getting a little “haven” bid.

Then the bonds rallied on Wednesday following what seemed to be a hawkish tilt from the Fed. I was genuinely perplexed. But bonds sold off hard on Thursday and Friday.

Not only were nominal yields rising, but real yields were also rising.

The yield curve has been flattening (don’t worry about inflation, the economy is slowing?)

volatility spike

I think of the S+P futures market as the best barometer for market risk on/off sentiment, but I also watch several different volatility metrics. S+P Vol gapped higher as markets got “back to work” after Labor day, then jumped to a 4-month high on Evergrande Monday, only to quickly retreat as the stock market rallied Tuesday through Friday.

Energy

Uranium prices have corrected after their sharp rally, New York Nat Gas has backed off from its highs, but crude oil and gasoline are aggressively bid.

Currencies

The US Dollar has sustained its rally from early September – especially against European currencies and the Yen.

The Canadian Dollar: strength/weakness in the S+P often impacts the CAD – this week, the CAD traded almost tick-for-tick with S+P futures. The relative strength/weakness of the USD Vs. other currencies also affects the CAD – but this week, as the USD was steady, the CAD rallied against most other currencies, perhaps because the commodity indices rallied to fresh 7-year highs – with a big boost coming from energy prices.

The Commitments of Traders report issued by the CFTC on Friday after the close (based on Tuesday, Sept 21 data ) shows the net long USD position to be the largest since Q1 2020. Large speculators were the shortest CAD they have been in over a year (remember they were hugely long in mid-June just after the CAD hit a 6-year high.) The AUD has a record net short position.

My short term trading

I started the week with a net short CAD position (short futures and short OTM puts.) I had been unable to bring myself to sell S+P futures in the hole the previous Friday but thought that the CAD would drop if the S+P kept falling.

The CAD tumbled with the S+P on Monday, and I wrote deeper OTM puts against my futures position. That was the high point of the week as far as my unrealized gains were concerned.

Monday evening (Pacific Time), I realized that I had a risk management problem. There was “no market” for my options. I had lowered the stop on my short futures position, but if the stop was hit, I would be net long the CAD (due to the short options) – with no way to cover them.

Sometime after midnight (as the European markets opened), bids and offers appeared in the CAD options – but the bid/offer spreads were WIDE and implied Vol had jumped – sharply increasing the prices of the options I was short. Mama Mia!

I covered all my CAD positions Tuesday and made a little money on the trade. By then, I had the idea that the panic that had caused the sharp sell-off on Monday had run its course, and I started buying Dow and S+P futures. I had my stops too tight and took small losses.

As much as I was right on my idea that the panic was over, I lost money buying the indices because the intra-day price swings were so much bigger and faster than they had been before the panic – and I couldn’t adjust how wide I needed to place my stops.

At the end of the week, my net P+L on realized trades was flat. I had come into the week bearish; the market had dropped, I had changed to bullish, the market had rallied, and, net, I didn’t make any money. Have I ever told you that trading is not a game of perfect? I ended the week flat.

On my radar

I think there has been a change in market psychology. As noted above, this week’s rally from Monday’s lows might have been reflexive. If the market rolls over and, especially if it takes out this week’s lows, I would be looking for opportunities to short stock indices, buy the USD, and I might even buy bonds!

Thoughts on trading

My trading time horizon got too short this week. My sweet spot is more of a swing trading time frame – a few days to a few weeks. I had experimented with shorter-term time frames where I would enter a market close to the point where I would stop myself out – using only price action to make trading decisions. (No supply/demand analysis etc.) I thought this would likely generate lots of small losses with occasional big wins. It probably works well for some people, but it doesn’t seem to suit me.

Finding the right time frame (that suits you) is one of the most important things for a trader. I don’t think all of my trading has to happen within the same time frame – the market doesn’t always move at the same speed – but I think there has to be a “pace” to my trading that allows for reflection – not just intuition.

I’ll wrap up this week’s Notes with a quote from Denise Shull’s recent interview on RTV. She runs the ReThink Group, providing performance coaching for traders and professional athletes. She said, “People think they make decisions based upon their analysis – but actually, they make decisions based upon how they “feel” about their analysis.”

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Victor Adair retired from the Canadian brokerage business in 2020 after 44 years and is no longer licensed to provide investment advice. Therefore, this blog, and everything else on this website, is not intended to be investment advice for anyone about anything.